Last week’s Consumer Price Index (CPI) release spooked a few people with a month to month change of 0.4%, the largest since February 2013; food prices were up 0.7% and the CPI ex-food & energy up 0.3% with both rising the most since August, 2011.  To top it all, the twelve month change in the CPI was 2.1%, above the Fed’s 2% target.

The immediate responses were (1) the Fed is going to raise interest rates a lot sooner than anyone expects and (2) the Fed will still wait for at least a year before raising rates and by that time the central bank will be “behind the curve” and inflation will have returned with a vengeance. Anxious bond holders believe the first story while unreconstructed monetarists (who are still waiting for inflation after five years of quantitative easing) put their faith in the second story.

The Fed chair, Janet Yellen, doesn’t believe either story. Rather, she is far less concerned about inflation and less worried about last week’s CPI report than most.  First, the CPI may, or may not, be a reliable gauge of inflation, but it is not the gauge the Fed follows.

The Fed bases its policy guidelines on the personal consumption expenditures (PCE) implicit price deflator.  The twelve month increase in that measure in April was 1.6%. (The May number isn’t available yet.) While that is higher than recent figures, it is comfortably below the Fed’s 2% target and it is in the range of the Fed’s economic projections published last week. Using the right numbers, inflation is exactly where the Fed’s policy guidelines expect it to be.    The Fed’s projections for the PCE Deflator are 1.5% to 1.6% for 2014; 1.6% to 2.0% for 2015 and 1.7% to 2.0% for 2016.

Other inflation measures do not point to a jump, or even a modest rising trend, in inflation. The Cleveland Federal Reserve Bank publishes a range of inflation indicators.  The Median CPI is one of the more reliable figures and it was 0.3% per month in April and May compared to 0.2% in January through March.  Both major consumer and professional forecaster surveys do not expect any increase in inflation.

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